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Views From the IMF Meetings: Better Growth to Continue in Developed Markets and in Latin America

October 18, 2017

Our main takeaways from the IMF meetings held in Washington D.C. from October 13 to 15, 2017

Below we present our main takeaways from the IMF meetings held in Washington D.C. from October 13 to 15, 2017:

1 – Better global growth will continue due to the continued slack in developed markets (allowing for loose monetary policy) and the reduced risks related to EM (including leverage in China). The IMF argues that global recovery is still in the incipient stages as the world continues to emerge from the three big shocks of the past ten years: the financial crisis, euro debt crisis and commodities collapse. In this context, an IMF report on wages in DM concluded that: i) these economies still have spare capacity; ii) wage growth in economies with very low unemployment rates could remain low (even after accounting for low productivity) as a result of involuntary part-time employment, among other factors; and iii) monetary policy in the developed world could therefore remain accommodative. Meanwhile, the fact that private sector debt in China has stabilized as a proportion of GDP (albeit at a high level) reduces the risks for global economic recovery.

2 – Risks are perceived as moderate. Trade protectionism concerns are currently restricted to NAFTA. While geopolitical risk exists, the probability of a war is low. The presidential and legislative elections in France created the perception of a reduced risk of populism in Europe.

3 – In the U.S. there is still skepticism over the tax reform, while the potential change in the Fed’s leadership is unlikely to affect monetary policy decisions. The Fed’s strategy is seen as successful in normalizing policy (reducing balance sheet, rising interest rates), while maintaining growth around 2% and bolstering expectations that inflation will gradually rise toward 2% – so there is no reason for risky innovations.

4 – Optimism about Europe: growth likely to remain solid, while structural reforms offer upside. Growth will remain strong and the European central bank will adjust policy while remaining accommodative. Two possible structural reforms in the EU in 1H18 are not fully priced: completing the banking union and transforming the ESM into a stabilization fund to deal with shocks.

5 – China-related risks have eased. Private debt as a proportion of GDP is high but has started to stabilize, and economic policies are unlikely to change after the Communist Party Congress in October.

6 – With the benign external environment, economic recovery is also spreading throughout emerging markets, particularly in Latin America. Growth is improving in Argentina, Brazil, Chile, Colombia and Peru. In Mexico, the economy has been robust despite the uncertainties over trade relations with the U.S.

7 – In Brazil, the central bank is comfortable with the inflation outlook: the output gap is sizable, so the recovery is unlikely to create demand-side pressures on prices anytime soon. While this means that interest rate hikes are far away– as long as domestic or external events do not lead to a significant weakening of the BRL – it seems that the decision to bring the Selic rate to below 7% (the yearend consensus forecast for this year and the next) is being postponed (we see the easing cycle ending with the Selic rate at 6.5%).

8 – Although investors see next year’s presidential election in Brazil as a risk for the continuity of the reform agenda, consensus is that policy direction will not change. It also seems market participants attribute a small (if not zero) probability of a social security reform being passed this year (even if further watered down), so there is upside for Brazilian asset prices if the government manages to pass some items of the proposal.

9 – The risk of a NAFTA breakup is rising, but the U.S. has incentives to reach an agreement. It is unclear whether President Donald Trump can really withdraw from NAFTA without approval from the U.S. Congress and, even if he can, it could cost him some needed support for his tax reform proposal. Furthermore, many people see “life after NAFTA” for Mexico. After all, Mexico would still enjoy low tariffs in the U.S. market if it trades under WTO rules.

10 – Amid the uncertainties surrounding NAFTA, the presidential elections, and monetary policy tightening in the U.S., rate cuts in Mexico are unlikely. In the near term, some board members (not the majority) see the possibility of further rate increases.

11 – In Argentina, a positive outcome for the government in the mid-term elections seems like a done deal, and markets are now focused on how to fix the imbalances in the economy (high inflation and wide twin deficits). Specifically, it is unclear how the central bank will bring inflation down, given the solid growth and absence of room for significant real exchange-rate gains (due to the wide external deficit). Rate cuts are unlikely in the near term, and there is a growing probability of more hikes. There has been progress on the fiscal side: the government recently sent a bill to congress that, if approved, would limit real primary expenditure growth to zero, which would help narrow both the fiscal and current account deficits and also help the central bank fight inflation.

12 – In Chile, the recent downward CPI surprise is unlikely to trigger further monetary easing, considering that activity is recovering. Rising copper prices are likely to help activity gain further momentum by boosting investment (which has been a key drag to growth).

13 – In Colombia, a currently divided monetary policy committee will likely agree to reduce interest rates further, but inflation must decline first. Rate cuts in the first quarter of 2018 are likely.